The following companies are overvalued like many stocks were during the dot.com era. The overall market has experienced solid gains, but is still not historically out of whack the way these companies are. Many investors apparently are not concerned with the overvaluations of these stocks, as their prices keep rising. Amazon (AMZN), Netflix (NFLX), Tesla (TSLA), and LinkedIn (LNKD) are all great growth stocks, but they are now priced way beyond rational valuation levels. This large discrepancy in valuation has these companies in bubble territory.
These irrational valuation levels bring up an interesting question: Are there still buyers out there to continue bidding up the prices of these stocks? Ultimately, the price of these stocks is driven by having more buyers than sellers. Normally, stocks rise approximately in proportion to their earnings growth over time. However, these companies are trading at levels that are many times higher than the average S&P 500 stocks. When does this buying end if the valuation fundamentals are so far away from normal levels? Let's take a look at some of the key fundamentals of these companies.
Price to Sales
Price to Book
38% Q2 2013
5-Year Expected Annual Earnings Growth
The obvious statistic that these four companies have in common is above average expected annual earnings growth for the next five years. This is what has driven these stocks to their current lofty levels. It's the expected future earnings growth, not the past earnings performance that has taken these stocks higher. Strong expected revenue growth is another likely reason for the sharp increases in stock price. All four companies have expected revenue growth of over 20% for the current year and for next year. TSLA's revenue growth is actually expected to increase over 400% from last year to this year. LNKD is expected to increase revenue by 55% this year over last year.
The fact that these companies are so far removed from average valuation levels puts them at risk of falling quickly and drastically in the face of unexpected negative news. This was evident a few years ago when NFLX changed its pricing policy. Investors did not like the decision and the stock went from trading over $250 down to the $50s. However, the stock has recovered since then and is now trading over $300. AMZN also had a sizable drop in price from about $240 to the $170s in Q4 2011 as a result of a 73% drop in Q3 2011 earnings. AMZN has also recovered since then and now trades over $300. Although these companies are back in favor for investors, it is difficult to determine when the buyers will dry up. If the institutional investors decide to unload their holdings in any of these companies, huge price drops could take place in a short period of time. Some type of negative catalyst would be needed for a shift from buying to selling to trigger a sell-off in these stocks. This could be a disappointing earnings report, lowered earnings guidance, or other negative news regarding the company.
I wouldn't short any of these stocks right now without some form of negative catalyst that would change the company's outlook. Investors should be aware of the risk of a sharp sell-off in these stocks due to their lofty valuation levels. The recent report of a Tesla car catching on fire is probably not enough of a negative catalyst for the company as it appears to be an isolated incident. However, reports of multiple cars catching on fire due to a serious manufacturing issue would likely trigger a sharp sell-off in the stock. For now, these stocks are likely to continue higher as the valuation irrationality continues. Buyers beware.